Fed’s Regulatory Powers Challenged Under Senate Plan

November 11, 2009 at 12:00 AM EST

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More than a year after the economic crisis hit, legislators continue to work on how to reform financial regulation and stave off a future crisis. The latest proposal comes from Sen. Chris Dodd of the Senate finance committee. Financial experts review the plan.

TRANSCRIPT

JEFFREY BROWN: More than a year after the economic crisis hit, legislators continue to work on how to reform financial regulation and stave off a future crisis.

The latest proposal came yesterday in the form of an 1,100-page draft from Senate Banking Committee Chair Chris Dodd. At a news conference, the Connecticut Democrat declared the previous regulatory regime had failed.

SEN. CHRISTOPHER DODD, D-Conn.: The financial crisis exposed a financial regulatory structure that was the product of historic accidents, one after another, over the past 80 years, created piece by piece over decades, with little thought given to how it would function as a whole, and unable to prevent threats to our economic security.

JEFFREY BROWN: Dodd called for effectively stripping the Federal Reserve and the Federal Deposit Insurance Corporation of the power to regulate banks.

Instead, his bill would establish a new financial institutions regulatory administration to consolidate oversight of the nation’s banks into one entity. There would also be an agency for financial stability to identify and regulate firms considered too big to fail, and a consumer financial protection agency to oversee mortgages, credit cards and the like.

As he laid out his plan, Dodd was highly critical of the Federal Reserve, while at the same time insisting he’s not out to punish the institution.

SEN. CHRISTOPHER DODD: I really want the Federal Reserve to get back to its core enterprises, in a sense, to do what it’s designed to do, monetary policy, dealing, obviously, with a lender of last resort, the payment systems. Those are what they’re designed to do.

We saw over the last number of years, when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure.

JEFFREY BROWN: By contrast, a bill in the House offered by Financial Services Chair Barney Frank, while sharing some goals and features of Senator Dodd’s proposal, maintains a powerful bank regulatory role for the Fed.

The Federal Reserve, in fact, remains a lightning rod in this debate, as many Republicans and Democrats are eager to rein in what they see as an all-too-powerful institution.

Republican Congressman Ron Paul of Texas has authored a bill that would audit the central bank’s monetary policies and decisions, an idea that Fed Chairman Ben Bernanke has publicly opposed.

And some perspective now from two people who have joined us at points along the way this past year, Joe Nocera, a financial columnist for “The New York Times,” and Simon Johnson of the MIT Sloan School of Management and the Peterson Institute for International Economics.

Well, with all these proposals swirling around, help us think about the problem of reorganizing the regulatory system.

For example, Joe, starting with you, is it most important who does it or what exactly they do, or both?

Revamping regulation

Simon Johnson

Economist

The key is, obviously, you want a tough regulator going forward. You want an institution or a set of institutions that aren't going to be captured by the banks.

JOE NOCERA, The New York Times: Well, it is really most important what -- what they do.

You have a series of issues that need to be dealt with. Too big to fail is one of them. What do you do about derivatives is another one. How do you protect the consumer is a third.

And, you know, if you had a system where you felt the banks were adequately regulated with three or four agencies vs. one agency, you know, that's really not the issue.

What's happening here is, for practical reasons, the House is saying and the president is saying, we don't want to -- the chaos, the political chaos that will ensue in trying to reduce three or four banking regulators to one.

And Senator Dodd is saying, you know, we're -- the country is better off with one regulator. The three or four regulators created the mess in the first place, and, you know, we shouldn't be, you know, compromising now. We should be tough.

And that's really what the divide is.

JEFFREY BROWN: Simon, how do you -- what's the key to you for thinking about how to -- how to revamp the system?

SIMON JOHNSON, senior fellow, Peterson Institute for International Economics: Well, the key is, obviously, you want a tough regulator going forward. You want an institution or a set of institutions that aren't going to be captured by the banks.

Last time around, and the time before that and the time before that, the banks persuaded the regulators that they were very clever, and they had all kinds of new ways of doing things, and everything would be all right. And they failed again and again.

The question is, what's better, one strong regulator, three or four regulators, as Joe said, or give it all to the Fed, and gamble that, this time, they can get it right?

Solving 'too big to fail'

Joe Nocera

New York Times

The Obama administration has punted on too big to fail from the start.

JEFFREY BROWN: One thing we have talked about a number of times on the program -- and you bring it up all the time -- is the too big to fail. Joe just mentioned it again.

What do you see here that is addressing that in positive ways or not enough?

SIMON JOHNSON: Well, there's a little progress on this issue in the Dodd bill. If I give it the most positive possible interpretation, they say the financial stability agency should be able to break up banks that become too big, irrespective of whether they're doing well or not. So, that's a step in the right direction.

But, really, that issue, what we do with these massive banks that, if they fail, they bring down the system, is not being addressed enough, either in this bill or in the Frank bill, and definitely front and center of the administration's original proposal.

JEFFREY BROWN: Joe Nocera, what do you see on that? Because that central issue of dealing with the big banks, and how big they are, and who regulates them, where are we at now?

JOE NOCERA: I couldn't agree more with Simon.

In England, and Europe in general, this issue is much more on the table. They don't have a solution, exactly, but they are talking about it in a much more serious way.

The Obama administration has punted on too big to fail from the start. It is a hard thing to grapple with. It is not bring back Glass-Steagall, because that's really not the issue. The issue is, is an institution systemically risky enough that something needs to be done, besides figuring out a way to shut it down, although that's helpful, too?

So, you know, if you have one Goldman Sachs, maybe you should have five Goldman Sachs, or five Morgan Stanleys that are smaller in size. These are issues that this Congress just does not want to tackle.

The politics of reform

Joe Nocera

New York Times

Surprisingly, the bank lobby remains stronger than you would think they would, given the mess that they helped create.

JEFFREY BROWN: Joe, there's also, of course, inevitably, the political aspect to this. You have Senator Dodd, he's running for reelection. You have public anger out there, right, at all the banks. You have Republicans and Democrats are talking about getting together, but so far not.

How does that play into the potential for reform?

JOE NOCERA: Well, not in good ways, is the truth.

Surprisingly, the bank lobby remains stronger than you would think they would, given the mess that they helped create. And, so, they really did wind up watering down the House bill quite a bit. On the Senate side, I think you're exactly right, that Senator Dodd, facing a tough reelection, and long been viewed, especially once he became a friend of Angelo Mozilo, and so on and so forth, and he got...

JEFFREY BROWN: That's from Country -- the head of Countrywide, right?

JOE NOCERA: For Countrywide, that's right.

He got tarred with that a little bit. So, he wants to come forward with a very tough bill.

One of his problems is that Senator Shelby, on the Republican side, who is very well-respected in banking -- among his colleagues as a banking expert, is not going along with this bill. And given the way the Senate works, where you need 60 votes, it will be very tough to get anything even close to this bill on the Senate floor without a Republican on or two.

The power of the Fed

Simon Johnson

Economist

It is very unsatisfactory to many members of Congress and then to pretty much all the American public what happened prior to September of last year.

JEFFREY BROWN: Simon, another issue is the Fed. I mentioned in setup that it has become such a lightning rod. To what extent is it justified? I mean, to what extent that does it do things well that we know? To what extent should we be thinking -- or is everybody right to be thinking about its future role?

SIMON JOHNSON: Well, the Fed has done a great job since about September 17 or 19 last year in terms of managing the...

JEFFREY BROWN: That's true of a lot of people, right?

SIMON JOHNSON: Well, actually, the Fed stands out as really having done a good job in saving the day.

When the entire financial system was on the precipice and things could have got really bad, the Fed stepped in, and Ben Bernanke showed a lot of leadership, made some brave steps.

The question is, what happened before that? What was the Fed's role during the boom? What was their role in assessing the risk? What was their role in regulating under Alan Greenspan and also, I have to say, under Ben Bernanke?

And the answer is, it was very weak. It was very poor. And it is very unsatisfactory to many members of Congress and then to pretty much all the American public what happened prior to September of last year.

JEFFREY BROWN: And that explains why now you have all kinds of proposals to take away its powers?

SIMON JOHNSON: Yes, absolutely.

The particular lightning rod for Representative Paul and other members of the Congress is the lack of transparency around what the Fed does. Now, some of that is justified, when you're rushing around, doing lots of difficult things, and you don't want the market to know exactly who is being saved.

But the Fed, I'm afraid, has a long tradition of hiding more than it needs to. And that has really generated a lot of resentment on Capitol Hill.

JEFFREY BROWN: Joe Nocera, how do you see the situation with the Fed and the political pressures on it now?

JOE NOCERA: Well, first of all, I think it's incredibly important for the Fed to remain independent. I think that's one of its great strengths, especially in terms of setting monetary policy.

So, things like the Ron Paul suggestion are troubling to me. I worry that, the more the Fed becomes part of the regulatory system and they keep giving it more power, the less -- the harder it will be for the Fed to remain independent on all the things they need to remain independent of.

I will say, if Paul Volcker had been running the Fed during this prices, instead of Alan Greenspan, as we led up to this crisis, people wouldn't be talking about how weak the Fed was.

And it is -- a large part of the problem with the Fed was the guy who was in charge of it, who simply didn't believe in regulation. So, I am of sort of mixed mind as to whether the Fed should get more power or less power, because I do think that we have a warped view of the Fed because of Alan Greenspan's tenure.

JEFFREY BROWN: All right, a last quick thing from both of you.

The urgency here, or the sense of timing, given where we are now, Simon, is Congress moving too slowly, or is it better to take the time to get it right?

SIMON JOHNSON: Well, obviously, they're taking their time. And they will take a couple more months, the fastest possible scenario. This is the window for reform. If you don't do it now, you are going to run through another cycle like this, another boom-bust-bailout cycle.

So, do it now. Do it when you can.

JEFFREY BROWN: Joe Nocera?

JOE NOCERA: I agree with Simon, up to a point.

I do think that because they're racing to get this done during the window, I do worry about what the final bill will look like and what the unintended consequences of it will be. I think there's a lot things that are being rushed through that haven't been really thought through properly.

JEFFREY BROWN: All right.

Joe Nocera, Simon Johnson, thanks, both, again.

JOE NOCERA: Thank you.

JIM LEHRER: We will have another angle on banking reform Friday, when Paul Solman talks with Sheila Bair, head of the FDIC, the agency that insures bank accounts. You can submit questions for a special Web-only version of his interview on our Web site, which is NewsHour.PBS.org.

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